Question

1. A Vehicle Corporation is considering replacing a technologically obsolete machine with a new state-of-the-art robotic machine. They have compiled the following data for the new machine:

Cost of new machine needed                                                 $150,000

Annual net cash inflows                                                          $40,000

Salvage value of the machine in 10 years .$20,000

Useful life of the machine                                                        10 years

Required rate of return                                                                   10%

The company uses straight-line depreciation on all equipment.

a. What is the payback period for this machine? Ignore the impact of income taxes.

b. How is the payback period used in evaluating potential investments?

Answer 1

Payback period
Time	Amount	Cumulative
-	(150,000.00)	(150,000.00)
1.00	40,000.00	(110,000.00)
2.00	40,000.00	(70,000.00)
3.00	40,000.00	(30,000.00)
4.00	40,000.00	10,000.00
5.00	40,000.00	50,000.00
6.00	40,000.00	90,000.00
7.00	40,000.00	130,000.00
8.00	40,000.00	170,000.00
9.00	40,000.00	210,000.00
10.00	60,000.00	270,000.00
Payback period = 3 + 30,000/40,000
Payback period = 3 + .75 Years
Payback period = 3.75 Years
The payback period is an effective measure of investment risk. It is widely used when liquidity is an important criteria to choose a project.
Since company is able to recover its cash outflows in the fourth year therefore company should go ahead with the proposal